The Prime Minister has dumped a defamation law under which journalists could have been jailed for their reporting of election campaigns, after Labour MPs agreed it had become a political embarrassment.

The backdown followed a warning yesterday from NZ's main news organisations that the proposed law change would force them to severely restrict coverage of politicians' statements during the next campaign.

"We have listened to concerns that have been raised," Helen Clark told Parliament today.

"While we do not believe they are legitimate, we did not consider it worth pursuing the matter further.

"The Government caucus has been overcome by the Christmas spirit."

Before today's caucus meeting, Government sources said ministers had already concluded that the provision was now more trouble than it was worth.

The amendment to the Electoral Act would have made it a criminal offence to publish or broadcast in the month before an election an untrue statement that defamed a parliamentary candidate and was intended to influence votes.

If convicted, the publisher or journalist would have faced a fine of up to $5000 or three months in jail.

The Government argued that the amendment was needed to stop people making statements which were false and defamatory during the final days of a campaign, leaving no time for them to be checked or effectively rebutted.

But news organisations and some Opposition parties said the clause struck at the Bill of Rights' protection of free speech, was an unjustified attack on legally sanctioned press freedoms and was unnecessary.

The clause restored the offence of criminal libel, which was removed from the statute books in 1992.

National MPs accused the Prime Minister of instigating its restoration, citing a criminal libel action taken against the chairman of the General Practitioners' Society, Dr Roger Ridley-Smith, after pamphlets were circulated in Helen Clark's electorate in the final week of the 1990 campaign.

The Prime Minister told Parliament today that the clause had been inserted after colleagues raised "general concern" about the growing use of personal denigration as a political weapon.

"During an election campaign, the use of smears and lies can be especially damaging."

The chairman of the New Zealand section of the Commonwealth Press Union, Herald editor-in-chief Gavin Ellis, said he was pleased the law change had been dropped.

But he took issue with the Prime Minister, saying the news media's concerns had been legitimate.

It was possible the Government had not thought through the ramifications of the legislation.

"We did - and put those to the Government. The arguments have succeeded. The real winners are the public."

In a letter to the Prime Minister, 15 major news organisations - including the Herald, TVNZ, TV3 and Radio New Zealand - warned that the new law would have meant the end of live election campaign reports and television debates.

Journalists would not have published information supplied by politicians until it had been verified.

Helen Clark described the response of media organisations as disproportionate.

The Act Party's justice spokesman, Stephen Franks, said a principled stand by the media had won the day.

But neither the Prime Minister nor Attorney-General Margaret Wilson, who was in charge of the legislation, had acknowledged they were wrong.